The last time refiners enjoyed comparable levels of profitability occurred from the end of 2004 to the end of 2007. During this Golden Age of Refining, shares of Valero Energy Corp (NYSE: VLO)–the largest independent refiner in the US–generated a total return of 209 percent, handily outperforming the 119 percent gain posted by the S&P 500 Energy Index.
The elevated 3-2-1 crack spread has prompted some analysts to suggest that the refining industry has entered a second Golden Age. However, investors must understand the differences between the current environment and the 2004-07 bull market for refiners.
In the first Golden Age, a combination of rising demand for refined products and a shortage of US refining capacity drove up margins in North America. No new refineries have been built in the US since 1976, while operators closed some refineries because profit margins remained weak throughout much of the 1990s and early 2000s. This situation reversed as surging demand growth for refined products in China and other emerging markets outstripped the expansion in global capacity. Expanding an existing refinery or building a new facility requires significant amounts of time and up-front investment; several years passed before the refining industry could roll out sufficient new capacity.
Rising demand isn’t behind the latest up-cycle in the North American refining industry. Sluggish economic growth and the elevated prices of petroleum products have conspired to weaken domestic consumption. US oil demand declined to less than 19 million barrels per day in 2011 from almost 21 million barrels per day in 2005.
Today, global refining capacity matches end-market demand reasonably well, though the industry endured a rough patch when demand plummeted during the last global economic crisis.
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Elliott and Roger on Sep. 27, 2022